How to Avoid Ruining Your Business by Succumbing to the Sunk Cost Trap

Most people are somewhat familiar with the idea of the sunk costs trap. A sunk cost is a cost that is already incurred and cannot be regained. Once you’ve paid for a non-refundable item or committed hours to a project, you can’t get that money or time back. The sunk costs trap is the issue that once someone has invested in an idea or project (whether the investment is in time, money, etc.) he/she is less able to accurately assess whether or not to keep investing in the idea or project because he/she cannot help but add the sunk costs into the equation.

Objectively speaking, these sunk costs should have no bearing on the decision of whether or not to invest more time or money moving forward. The investments have been made and cannot be regained, so the logical analysis is about the evaluation of potential future outcomes, not the past sunk costs. In reality, however, it is very difficult to escape this trap. In fact, it is so difficult to avoid that many use it to their advantage: they look to invest in and partner only with others who “have some skin in the game” because they recognize that a person who has invested personally will have a harder time walking away.

Unfortunately, this can spell disaster for small businesses because resources are tight so they typically cannot afford to continue to “throw good money after bad.” If the entrepreneur isn’t able to recognize a bad investment, ignore the sunk costs, and walk away from it quickly, he/she may run the company into the ground attempting to save a lost cause of a project or product.

So how can an entrepreneur train himself/herself to avoid this trap? There’s no sure-fire way, but here are some of the most successful techniques that will help you avoid the sunk costs trap:

  1. Before beginning a new project that will require investment up front and therefore has potential to develop into a sunk costs trap, clearly define performance metrics that must be met in order to keep the project alive. If you’re investing in a new marketing program, decide on the necessary ROI and how long you’re willing to wait to get there before you begin. Then, as long as the goals are realistic and appropriate, when you reach the end date you’ve given yourself there should be no question about whether to continue the project or pull the plug. If you reached the ROI, the project was a success and you should keep going. If you didn’t reach the ROI, the project was not a success and you should shut it down even though you’ve already invested time and money. Defining success (both in terms of outcomes and timelines) before the project starts leaves less room for you to rationalize continuing due to sunk costs. If you can automate this stop or continue decision, even better.
  2. Whenever you’re about to make a decision about something you’ve already invested in, first remind yourself about the sunk costs trap. Just reminding yourself that you’re susceptible to making an irrational decision will help you make a rational one.
  3. Try changing the scenario to depersonalize it while keeping the ultimate choice the same. For example, let’s say you’re a non-profit organization and you need volunteers. Your newest project has used up 20 hours of your current volunteers’ time and has resulted in 10 pledged volunteer hours. Instead of thinking about all of the time your team has put into this project so far, think about investing $100 to get $50 back. Would you continue to invest? No, of course not. So why should you continue to invest in this volunteer project when the ROI is equally poor? By separating the choice from the emotional tie to the investment you’ve already made, you’ll make the right choice clearer.
  4. Honestly think about what you would advise a friend or family member to do in your situation. If you would tell him/her to get out before he/she loses even more, you should get out. You wouldn’t lie to a friend or family member about the chances for success of a project and let him/her get burned. Don’t lie to yourself either.
  5. Just in case you can’t be honest with yourself, ask someone who knows you well to be brutally honest with you instead. Have him/her tell you what he/she thinks you’d tell someone else in your situation. If he/she thinks you’d tell the person to crush the project as quickly as possible, you should probably consider crushing it.

What are the best tricks you know for avoiding the sunk costs bias trap? Please share what’s worked for you!

 

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